“It’s a silver miner pretending to be a gold miner, end of story,” Rock concluded. “It’s profitable now, which is good, but it’s hugely overvalued for what it is, even what it promises to be later. And finally, let’s remind ourselves that GORO hasn’t bothered to put together a 43-101 (independent engineering report), and nobody really knows whether what they say about their PM (precious metal) deposits is true or not.

“But what ‘Silver-with-a-Bit-of-Gold Resource Corp.’ does have,” he added, “is a legion of fanatical gold-bug loopheads as shareholders … people who give gold bulls like myself a bad name.”

GORO did not respond to messages, including a detailed list of questions, seeking input for this story.

Within a year, GORO had landed the first of twoearly financing partners that would eventually lose their enthusiasm – and curtail their funding – for that celebrated gold mine over time. GORO initially teamed up with Canyon Resources in 2003, records show, securing $500,000 that originally looked like a mere down payment on a much larger $3.5 million funding deal for shared ownership of the company’s Mexican gold mine. Although GORO reported impressive drilling results in the months that followed, however, the company never scored another dime from Canyon Resources and soon found itself hunting for a brand-new source of cash.

GORO located its next partner on the opposite end of the globe, with Australian-based Heemskirk stepping forward with $1 million in exchange for 2 million shares of GORO stock in 2005 and becoming the largest outside shareholder of the company. To further sweeten the deal, GORO promised Heemskirk first rights to purchase all or part of any future stock that the company issued over the course of the next three years.

Despite the net loss and negative cash flow reflected on its financial statements last year, however, GORO boldly proclaimed that its gold mine not only generated a profit but also provided enough money to finance a generous dividend to boot.

By carefully excluding key expenses related to its business – including the costs of overhead, exploration, construction and development – GORO has managed to create its own metric known as “mine gross profit” that suggests the company is operating in the black. Using that selective measure, GORO reported a mine gross profit of $9.8 million last year that more than covered the $7.74 million that it spent on dividends.

When Hochschild suddenly installed new leaders in the spring of 2010, however, the company also adopted a new business strategy as well. Instead of heavily investing in other miners (such as GORO), Hochschild announced that it would pursue organic growth through mines that it actually controlled instead.

At that time, records show, Hochschild owned big minority stakes in two miners – Lake Shore Gold (Toronto: LSG.TO) and GORO itself – that could both be liquidated for sizable returns. Hochschild bypassed the opportunity to buy more stock in the first company a few months later, choosing to simply accept the dilution hit instead.

“Hochschild remains supportive of Lake Shore Gold,” the company said at the time. “However, the board and management team see organic growth through investment in Hochschild’s extensive and rapidly expanding exploration pipeline as the company’s key priority. As a result, Hochschild will not be participating in the proposed financing, and its current 37% holding in Lake Shore Gold will be diluted to approximately 35%.”

However, unless Hochschild can find a buyer willing to purchase that huge chunk of stock in a prearranged “block” deal – a real challenge since GORO, unlike Lake Shore, has never formally established any gold reserves – the company faces a serious dilemma. Hochschild can hold onto the stock and settle for enormous gains on paper, the strategy that it has chosen so far, or the company can risk selling its stock on the open market – almost assuring a devastating hit to the share price – and simply hope to collect as much money as it possibly can.

Desert Storm

Either way, Hochschild can hardly depend on GORO to boost its deteriorating operational results. Since Hochschild does not lean on a convenient metric like “mine gross profit” to bolster its own numbers, the company must record its share of any losses that GORO suffers and book only the modestearnings that GORO can muster after covering its operating costs.

During the first quarter, for example, GORO reported net income of $2 million and dividend payments that came to almost 2.5 times that amount. While GORO narrowed that gap in the second quarter (and even boosted its cash for a change by almost doubling the amount owed for outstanding bills), the company still generated net income of $3.06 million that covered less than half of the $6.36 million that it spent on those dividend payments.

For its part, GORO chose to emphasize a higher net-income figure that excluded costs associated with the bizarre rainstorm blamed for its latest production shortfall. On April 21, three weeks into the second quarter, GORO suddenly warned that a freak storm – which reportedly dumped more than 10 inches of rain on Mexico in the span of three short hours – had slammed its gold mine and would likely hurt its financial results.

Yet, according to an official crop report compiled by the U.S. Department of Agriculture, the heaviest rainfall recorded in Mexico came to barely one inch for the entire week when that massive storm reportedly occurred. Moreover, since then, Mexican newspapers have indicated that the country was suffering through an “extended dry spell” in April – which began last October and relentlessly continued through the middle of this year – that threatened to become one of the most extreme droughts the nation has ever seen.

“The current situation is critical because rainfall has not been as scarce at any time in the past 70 years,” Mexican weather authorities told the press in late June. “There are years that the country will be wetter than usual, like last year, and years that will be drier than usual. This is a rain deficit.”

After an extensive search, TheStreetSweeper finally managed to uncover limited news coverage of a “freak hailstorm” that hit Mexico in April of this year. But the storm that sparked that media attention surfaced days before GORO reported its own downpour, a translator determined, while producing just three inches of rain (in a different region of the country) after it arrived.

"The mine was shut down for over a month (after the April 20th storm), as crews had to turn their attention to cleanup and repair," the CEO told investors during the company's latest conference call. "The months of April and May were very much subpar because of the natural disaster, with only the month of June getting back on track."

In fact, records show, GORO actually tapped StarShenkein (formerly Stark Winter Shenkein) as its independent auditor the year before the company joined a crowd of penny stocks on the OTC Bulletin Board. StarShenkein has since been flagged for shoddy work by the Public Company Accounting Oversight Board (PCAOB), recordsshow, which uncovered major deficiencies in all four of the audits it reviewed during a 2006 inspection of the firm and more than half of the eight audits that it examined during its latest visit.

“We chose to put this into production in the shortest amount of time possible, so we did not go some typical routes,” President Jason Reid (the son of the CEO) explained when fielding another inevitable question about the company’s lack of established reserves about a month ago. “Now, in the interim, we always had this third-party pushback, where I would go out and tell the story, and they say, ‘I love your story … (But) no offense, I don’t believe you.’

“It behooves us now to go more mainstream,” he continued, “and so we’re working on a third-party, or a more formal, resource report … But it’s solely for the market. We don’t need it for any other reason, other than it’s another box for funds to check.”

At this point, investors have already witnessed one massive fraud orchestrated by a gold miner with little independent oversight. In the mid-1990s, The Independent newspaper reported, Bre-X became a multibillion-dollar company (based on market value) after loudly celebrating the “gold find of the century.” But when outsiders actually conducted their own tests of that same mine, the newspaper noted, they found only “insignificant quantities of gold” and declared that Bre-X had falsified its results on a scale “without precedent in the history of mining.” After that, the newspaper added, the former highflier – which had impressed even the likes of Barrick with glowing reports of its mine -- wound up virtually worthless overnight.

In 1988, Dow Jones reported years ago, US Gold announced plans for a big expansion project designed to increase production and install the first commercial “bio-leaching” facility the industry had ever seen. Two years later, however, US Gold found itself facing “significant liquidity problems” due to cost overruns and repeated delays stemming from that ambitious project. Although US Gold barely escaped bankruptcy by selling off its interest in a Nevada gold mine, industry coverage has revealed, the company emerged from that liquidity crisis with unshaken faith in its future success.

“The mill’s design capacity is 50,000 ounces annually,” US Gold told a trade publication at the time. And “we see no reason to believe the mill won’t reach full capacity within a matter of months.”

“If you’re not worried, you’re not risking enough,” he nonchalantly told the Wall Street Journal in the midst of his first company's liquidity crisis. “I believe life should be an adventure. And we’re having a hell of an adventure right now.”

* Important Disclosure: Prior to the publication of this article, TheStreetSweeper (through its members) has effected a “short sale” of 74,246 shares of GORO stock at an average price of $25.28 a share with the intent of profiting from decreases in the share price. TheStreetSweeper has also purchased 50 September 2011 $30 "put" options priced at $5.80 apiece, hedged by the sale of 50 September 2011 $25 "call" options priced at $1.15 apiece, as well. TheStreetSweeper may choose to make additional trades in GORO securities, potentially covering part or all of its short position in the stock, and will fully disclose the details of those transactions as they occur.

Update: TheStreetSweeper covered 3,200 shares of GORO stock at a price of $23.23 a share on Aug. 23. It covered an additional 24,825 shares, including 4,156 shares purchased under a "forced buy-in," at an average price of $22.34 on Aug. 24. It covered another 17,790 shares at $22.19 a share on Aug. 25 and 10,310 shares at $21.43 a share on Aug. 26. It covered the remaining 17,621 shares at $22.88 a share on Aug. 29, closing out its short position in the stock. It sold its 50 September 2011 $30 put options at $8 a share as well.

Update: TheStreetSweeper began establishing a new short position in GORO on Aug. 30, when it sold 2,000 shares of the company's stock short at $24.03 a share. TheStreetSweeper covered that position at $23.35 a share on Aug. 31 and then sold another 75 shares of GORO short at $23.83 a share. It sold an additional 4,525 shares of GORO short at $23.47 a share on Sept. 1 and another 8,401 shares at $23.20 on Sept. TheStreetSweeper repurchased 75 shares of GORO under a "forced buy-in" at $22.47 a share on Sept. 6, and it sold another 4,600 shares of the company's stock short at a price of $22.48 a share on that same day. It sold an additional 9,080 shares of GORO stock short at $21.12 a share on Sept. 12 and another 4,000 shares at $21.39 on Sept. 13. Following those transactions, TheStreetSweeper had sold a total of 30,606 shares of the company's stock short at an average price of $22.28 a share. TheStreetSweeper has increased its short position to 40,506 shares, sold at an average price of $22.08 a share, since that time. Due to "forced buy-ins," however, TheStreetSweeper repurchased 3,389 of those shares at $21.60 a share on Sept. 15 and another 3,922 shares at $20.78 a share on Sept. 22. Since then, on Sept. 23, it purchased 8,394 shares at $19.35 a share and 14,300 shares at $18.29 a share in two separate transactions. It covered another 7,601 shares at $17.93 a share on Sept. 26. It covered the final 2,900 shares at $20 a share on Sept. 27 and no longer holds a short position in the stock. Going forward, TheStreetSweeper may choose to establish a new short position in GORO and will fully disclose the details of any future transactions as they occur.

As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in any of the companies that they cover. To contact Melissa Davis – the editor of this website and the primary author of this story –please send an email to editor@thestreetsweeper.org.